LIBOR TRANSITION: THE STATE OF PLAY - April 14, 2020 Noon, US Eastern Daylight time - Oliver Wyman
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LIBOR TRANSITION: THE STATE OF PLAY April 14, 2020 Noon, US Eastern Daylight time
DAN
ROSENBAUM
Partner, Retail and
Business Banking
OPENING
Dan.Rosenbaum@oliverwyman.com
REMARKS
LIBOR TRANSITION – THE STATE OF PLAY
AGENDA
Opening Remarks Dan Rosenbaum
1 State of the Transition with Guest Speakers Tom Wipf
and David Bowman
Tom Wipf
David Bowman
2 Regulatory Imperative and Transition Timeline Douglas Elliott
3 Lending with SOFR Esther Bruegger
4 Getting to Green through the Crisis Adam Schneider
5 Closing Remarks Dan Rosenbaum
Copyright © Oliver Wyman 3
OUR HOSTS
Dan Rosenbaum Madeline Kreher
Partner, Retail and Engagement Manager, LIBOR
Business Banking Platform
Dan.Rosenbaum@oliverwyman.com Madeline.Kreher@oliverwyman.com
OUR PANELISTS
Tom Wipf
Esther Bruegger
Vice Chairman of Morgan Stanley
Principal, Finance & Risk
and Chair of the ARRC Esther.Bruegger@oliverwyman.com
Thomas.Wipf@morganstanley.com
David Bowman
Senior Associate Director at the
Adam Schneider
Board of Governors of the
Partner, Lead LIBOR Platform
Federal Reserve Adam.Schneider@oliverwyman.com
David.H.Bowman@frb.gov
Doug Elliott Pin Su
Partner, Risk & Public Policy Engagement Manager, LIBOR
Douglas.Elliott@oliverwyman.com Platform
Pin.Su@oliverwyman.com
Copyright © Oliver Wyman 4
1 TOM WIPF
Vice Chairman of Morgan
Stanley and Chair of
the Alternative Reference
Rates Committee
STATE
OF THE
DAVID BOWMAN
Senior Associate Director at
TRANSITION
the Board of Governors of
the Federal Reserve
Alternative Reference Rates Committee
Update
Tom Wipf, Vice Chairman of institutional securities at Morgan Stanley and Chair of the
Alternative Reference Rates Committee
David Bowman, Senior Associate Director, Board of Governors of the Federal Reserve
Copyright © Oliver Wyman 6
ALTERNATIVE REFERENCE RATES COMMITTEE
The Federal Reserve convened the ARRC in 2014 to identify
a robust alternative to U.S. dollar LIBOR that met best
practices and to promote the use of that rate and robust ARRC Members
fallback language on a voluntary basis. American Bankers Association International Swaps and Derivatives Association
Association for Financial Professionals JPMorgan Chase
AXA KKR
Bank of America LCH
Following the remarks by Andrew Bailey at the UK’s BlackRock MetLife
Financial Conduct Authority (FCA) indicating that the Citigroup Morgan Stanley
CME Group National Association of Corporate Treasurers
continued production of LIBOR is not guaranteed beyond Comerica Pacific Investment Management Company
2021, the ARRC (2.0) was reconstituted in 2018 with an CRE Finance Council PNC
expanded membership to help to: Deutsche Bank Prudential Financial
Fannie Mae Structured Finance Association
Ford Motor Company TD Bank
Freddie Mac The Federal Home Loan Banks
1. Ensure the successful implementation of the Paced GE Capital The Independent Community Bankers of America
Transition Plan, Goldman Sachs The Loan Syndications and Trading Association
Government Finance Officers Association The Securities Industry and Financial Markets Association
2. Address the increased risk that LIBOR may not exist HSBC Wells Fargo
beyond 2021, and Huntington World Bank Group
Intercontinental Exchange
3. Serve as a forum to coordinate and track planning
across cash and derivatives products and market.
Ex Officio Members
Commodity Futures Trading Commission New York Department of Financial Services
In order to fulfill this mandate, the ARRC continues to Consumer Financial Protection Bureau Office of Financial Research
Federal Deposit Insurance Corporation Office of the Comptroller of the Currency
conduct the widest possible outreach, seeking input and Federal Housing Finance Agency U.S. Department of Housing and Urban Development
comments from all parties that may be affected by the Federal Reserve Bank of New York U.S. Securities and Exchange Commission
possible cessation of LIBOR after 2021. Federal Reserve Board U.S. Treasury
National Association of Insurance Commissioners
Copyright © Oliver Wyman 7
LIBOR TRANSITION TIMELINES AND COVID Statement by the UK Financial Conduct Authority (March 25) “The central assumption that firms cannot rely on LIBOR being published after the end of 2021 has not changed and should remain the target date for all firms to meet. The transition from LIBOR remains an essential task that will strengthen the global financial system. Many preparations for transition will be able to continue. There has, however, been an impact on the timing of some aspects of the transition programmes of many firms. “ https://www.fca.org.uk/news/statements/impact-coronavirus-firms-libor-transition-plans Statement by the Financial Stability Board (April 2) Benchmark transition. The transition from LIBOR remains a priority as firms cannot rely on LIBOR being produced after end 2021. Benchmark transition will help to strengthen the global financial system. https://www.fsb.org/work-of-the-fsb/addressing-financial-stability-risks-of-covid-19/ The ARRC is taking the timelines provided by the official sector as given and continuing its work, recognizing that although some near-term goals may be delayed, other efforts can continue Copyright © Oliver Wyman 8
ALTERNATIVE REFERENCE RATES COMMITTEE – TIMELINE
The ARRC was originally convened in November 2014. Significant progress has been made to
date.
May – CME launched SOFR futures
Jul. – LCH cleared SOFR Nov./Dec – U.S. Authorities
OIS and basis swaps issue accounting, tax, and
Apr. – FRBNY/OFR began margin relief proposals Create a SOFR term
Fannie Mae issued first
publishing SOFR reference rate
SOFR-based FRN Q3 – ISDA Protocol
Oct. – ARRC Paced Transition
Plan adopted Apr/May – ARRC issues FRB, Oct –LCH/CME
Loan, and Secruitization Mar. – FRBNY move to SOFR
fallback recommendations began publishing PAI/diiscounting
and Users Guide to SOFR SOFR averages
2016 2017 2018 2019 2020 2021
Mar. – ARRC’s Second report Jul. – ARRC’s issues Apr - ARRC’
May – ARRC published SOFR ARM Whitepaper recommended
Interim Report and Spread Adjustment Q4. – GSEs to stop
Consultation ARRC 2.0 reconstituted with Oct. – CME begins clearing announced LIBOR ARMs and
expanded membership Sep – ARRC issues start SOFR ARMS
Jun. – SOFR selected as SOFR swaps using SOFR
Implementation
recommended PAI/discounting and FASB
Checklist
alternative to USD LIBOR adds SOFR to its hedge
accounting list Nov. – ARRC’s issues ARM
Jul. – FCA Bailey: Official sector fallback recommendations
can no longer guarantee and agrees to pursue NY
LIBOR’s stability past 2021 legislative relief
Copyright © Oliver Wyman 9
ARRC WORKSTREAMS • Best Practices: date-based best practices for use of hardwired fallback language, vendor readiness, setting out successor rates for contracts that allow discretion, and ending use of LIBOR, • Conventions: final recommended conventions for SOFR-based floating rate notes, business loans, securitizations, and student loans • Fallback Language: revisions to the ARRC’s hardwired business loans fallback language (including a more permissive early opt-in trigger) and finalize recommended fallback language for new student loans referencing LIBOR • Legislative Relief: pursue potential legislative relief for legacy contracts that may be otherwise difficult to amend and that do not have economically appropriate fallbacks • Operations/Infrastructure: internal systems, work with external vendors • Reference materials: materials laying out actions that market participants could take in order to create clear and effective programs for consumer education and outreach as well as materials to educate market participants on tax/accounting relief. • Single Step: Move to SOFR PAI and discounting for cleared derivatives (October 2020). • Spread Adjustments: finalizing technical details and establishing an RFP process for selection of an administrator to publish the ARRC’s recommended spread adjustments and spread-adjusted rates. • Tax/Regulation/Accounting: continuing work with tax, regulatory, and self-regulatory organizations as they finalize proposals for transition relief • Term Rate: Establishing RFP process to select an administrator of an ARRC-recommended forward-looking term SOFR rate to be published in 2021 if liquidity in SOFR derivatives markets has developed sufficiently, and establish recommended scopes of use for the rate Copyright © Oliver Wyman 10
SOFR MARKETS • SOFR Futures trading has started at a faster pace than either Eurodollar Futures or Fed Funds Futures. Average daily volume is over $100 billion notional, with open interest surpassing $2 trillion • SOFR swaps trading FR in cash markets. SOFR OIS and basis swap trading has begun to pick up, but averages in the range of $30 billion per month. SOFR basis trades had a record month in March at CME. We have also seen recent SOFR cross- currency swap and options trading. • The floating rate debt market has been the first to take up SOFR, with over $500 billion in SOFR debt having been issued, with a record $150 billion issued in March • Fannie and Freddie are now developing the capability to accept SOFR ARMs based on this work and will stop accepting LIBOR ARMs. • We’ve seen several recent SOFR loans, and Ginnie Mae and Freddie Mac have issued securitization with payments based on SOFR. Copyright © Oliver Wyman 11
MOVEMENTS IN SOFR
Averages of Treasury repo rates move quite closely with the fed funds effective rate and the Fed’s
monetary policy targets and are relatively unaffected by any volatility in daily SOFR rates.
SOFR has moved down with the reduction in monetary policy targets to the zero lower bound, and
is currently about 1 basis point, a few basis points lower than EFFR. Market expectations are for
SOFR rates to move up to EFFR rates.
Repo Rates Like SOFR Move Closely with Other Risk-Free Rates
7%
6%
5% Quarterly Compound SOFR/PD Survey
4% Quarterly Compound EFFR
3%
2%
1%
0%
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020
Copyright © Oliver Wyman 12MOVEMENTS IN RISK-FREE RATES VS LIBOR
There are differences between LIBOR and risk-free rates like EFFR and SOFR, but it is important to
keep in mind that over the long run, LIBOR has actually moved up and down with monetary policy,
as do risk-free rates. These changes in monetary policy expectations account for 99% in the
movements in LIBOR over the last 30 years. And, from a borrower perspective, the times that
LIBOR has risen relative to risk-free rates may not actually be an attractive feature.
Over the Long Run, LIBOR and Risk-Free Rates Move 3-Month LIBOR-OIS Spread
Percent Basis Points
Closely Together 400
12 350
10 3-Month EFFR term 300
OIS rate 250
8 3-Month Libor
200
6 150
4 100
50
2
0
0 -50
1988 1992 1996 2000 2004 2008 2012 2016 2020 1988 1992 1996 2000 2004 2008 2012 2016 2020
Copyright © Oliver Wyman 13SOFR AND BANK FUNDING COSTS
Because banks are now far less dependent on wholesale unsecured funding, their holdings of
Treasuries and repo funding is now a larger proportion of their liabilities. Compound Averages of
Treasury repo rates were more correlated with bank funding costs than LIBOR, even over the
period covering the 2007-09 financial crisis.
Recently, wholesale unsecured funding volumes have dropped (the Federal Reserve has not
published its financial CP series since March 27, while low-cost core deposits and funding from
Federal Reserve facilities have increased notably, helping to lower overall funding cost even as
LIBOR has been rising.
Share of LIBOR Funding in Bank Correlations with Bank Funding Costs, 2006Q3-2011Q2
Correlation with Compound SOFR in
1
Liabilities
0.9
12.00%
0.8
10.00% 0.7
Advance
8.00% 0.6
6.00% 0.5
0.4
4.00%
0.3
2.00%
0.2
0.00% 0.1
0
-0.2 0 0.2 0.4 0.6 0.8 1
gsib_libor_share nongsib_libor_share Correlation with LIBOR
Copyright © Oliver Wyman 14
14Legacy Products and Fallback Language Copyright © Oliver Wyman 15
CASH PRODUCTS
The largest exposures to USD LIBOR (95 percent) are through derivatives, which are used to dealing
with overnight rates.
However, cash products have $8.4 trillion in exposure and large banks will have myriad connections
to these products and in many ways they will be more problematic since they do not tend to have
uniform documentation and do not have access to a protocol process to amend legacy instruments
as derivatives do.
Securitizations,
Exchange-Traded $1.8 trillion
Derivatives, $45 trillion
Syndicated Loans,
$1.5 trillion
Cash Products, Floating Rate Notes,
$8.4 trillion $1.8 trillion
Nonsyndicated CRE Loans,
Over-the-Counter Derivatives, $1.1 trillion
$146 trillion Nonsyndicated Business Loans,
$810 billion
Retail mortgages,
$1.2 trillion
Other Consumer loans,$63 billion
Copyright © Oliver Wyman 16ISDA PROTOCOL: CONVERTING LEGACY DERIVATIVES CONTRACTS
ISDA will amend its 2016 definitions to incorporate more robust IBOR fallbacks by the end of this year. It will offer
a protocol allowing legacy contracts to incorporate the new definitions at the same time.
ISDA concluded its first market consultation (of ISDA members and non-members) in October, 2018.
o This initial consultation was for Sterling, Swiss Franc, Yen LIBOR and Yen TIBOR and the BBSW rate.
ISDA concluded a supplemental consultation on USD LIBOR, CDOR, HIBOR and SOR in July 2019.
o Responses to the supplemental consultation were consistent with the first
ISDA has now finished consulting on final parameterizations. Responses to the two consultations showed a
cleared preference for:
Fallback Rate: Spread Methodology
Compounding Setting in Arrears Rate – the RFR Historical Mean/ Median Approach –
observed over the relevant IBOR tenor and Spreads would revert to a 5-year median of
compounded daily during that period the spread between the relevant IBOR and
RFR
Pre-Cessation Trigger: The OSSG has encouraged ISDA to include a trigger in the event that LIBOR has been
found to be non-representative
by the UK Financial Conduct Authority (the regulator of IBA LIBOR). CME and LCH have indicated that they will
trigger in these circumstances. ISDA has consulted on this issue but has not made any decision.
Copyright © Oliver Wyman 17ARRC HARDWIRED FALLBACK RECOMMENDED RATES WATERFALLS Copyright © Oliver Wyman 18
THE ARRC’S RECOMMENDED SPREAD ADJUSTMENT
The ARRC has recommended a spread adjustment based on a static, 5-yearar median of the
historical spread between LIBOR and SOFR, the same as ISDA’s choice for derivatives, with the
addition of a 1-year transition period for consumer products. A static spread adjustment appears
to work well, even in comparison to potential “dynamic” spread adjustments.
Table 1: Historical Errors Between Returns on a LIBOR Loan and Spread-Adjusted Rates Percent Illustration of a Transition Period to a Long-Run
1.10
Median
Mean Absolute
Loan with 1-year remaining maturity Error
Static Spread Based on 5-Year Median Spread to SOFR In 1-Year
Advance 0.10
0.80 LIBOR -…
Dynamic Spread Using 1-Month Financial CP Series 0.11
Mean Absolute
Loan with 5-years remaining maturity Error
0.50
Static Spread Based on 5-Year Median Spread to SOFR In
Long-Run Median
Advance 0.08
Dynamic Spread Using 1-Month Financial CP Series 0.11 Transition Period
Data sources: FRBNY, Federal Reserve Board, Refinitiv, and Federal Reserve Board staff calculations. 0.20
Annualized differences in returns (in percentage points) in a loan based on 1-month LIBOR and a loan
2014 2015 2016 2017 2018 2019
based on a spread-adjusted rate. Mean Absolute Errors calculated over 1999-2019 and reported in
Source: Ice Benchmarks Administration, Refinitv, and Federal Reserve Board staff calcu
percentage points.
Copyright © Oliver Wyman 19ARRC PROPOSED NEW YORK STATE LEGISLATION FOR LEGACY
CONTRACTS
Key Components Possible Legislation Structure
• Mandatory: If the legacy contract is silent as to fallbacks.
“Mandatory” v. “Permissive” • Mandatory: If the legacy language falls back to a Libor-based rate (such as last-quoted Libor).
Application of the Statute • Permissive: If the legacy language gives a party the right to exercise discretion or judgment regarding the fallback, that
party can decide whether to avail itself of the statutory safe-harbor.
• Override: Where the legacy language falls back to a Libor-based rate (such as last quoted Libor).
• Override: If the legacy language includes a fallback to polling for Libor or other interbank funding rate, the statute would
mandate that the polling not occur.
Degree of Override of Legacy
• No Override: Where the legacy language is silent as to fallbacks or gives a party the right to exercise judgment or
Contract Fallback Provisions
discretion regarding the fallback. In these instances, there is nothing to override.
• No Override: The statute would not override legacy language that falls back to an express non-Libor based rate (such as
Prime).
• Parties would be permitted to mutually opt-out of the application of the statute, in writing, at any time before or after the
Mutual “Opt-Out”
occurrence of the Trigger Event.
• The statute would become applicable or available (as described in “Mandatory” v. “Permissive” above) upon the
occurrence of statutory trigger events
Trigger Events • Cash Products: The statutory trigger events for cash products would be based on the ARRC permanent cessation
and pre-cessation trigger events
• Derivatives: The statutory trigger events for derivatives would be based on what ISDA does
“All Products” • No Exclusions: No product would be categorically excluded from the statute. Parties can opt-out as described above.
• The statute would be drafted to provide safe-harbor protection for parties who add conforming changes to their
Conforming Changes
documents to accommodate administrative/operational adjustments for the statutory endorsed benchmark rate.
Copyright © Oliver Wyman 20ARRC – STAY INFORMED • https://www.newyorkfed.org/arrc • Sign up for email updates • Office Hours Dial-In Information: –Fridays at 2:00 PM EST –1-855-377-2663 (U.S. callers) –+1 972-885-3168 (International callers) –Code: 09823427 Copyright © Oliver Wyman 21
ARRC – GET INVOLVED
ARRC 2.0
Derivatives Cash Products Support
Market
Floating Rate Consumer Infrastructure/ Tax and Regulatory
Structure/Pace Term Rate Business Loans Securitizations Legal
Notes Products Operations Accounting Issues
d Transition
SIFMA/ISDA
Official Sector
CCPS and SEFs
Copyright © Oliver Wyman 222
REGULATORY
Doug Elliott
IMPERATIVE Partner, Risk & Public Policy
Douglas.Elliott@oliverwyman.com
AND
TRANSITION
TIMELINE1 Why are the authorities forcing a change? 2 Who are the key authorities? 3 Will LIBOR really go away? 4 Will it happen on the original schedule? 5 What key decisions are still to be made by authorities? 6 How is the transition coordinated globally?
3
ESTHER
BRUEGGER
Principal
Esther.Bruegger@oliverwyman.com
LENDING
WITH SOFR1 What is the background on lending with SOFR?
2 What are the regulatory concerns with respect to loans?
3 What are the considerations in repricing loans “fairly”?
What are the concerns for new SOFR-based products? How will
4 clients react?
Do we really need to analyze this, or just let “the market”
5 decide?
6 The Fed’s Main Street Lending is using SOFR?LENDING WITH SOFR
LIBOR and SOFR in crisis scenarios
Repricing existing LIBOR products
Designing new products referencing SOFR
• Clients’ needs and SOFR product design
• Pricing of SOFR products
Copyright © Oliver Wyman 27LENDING WITH SOFR
LIBOR and SOFR in crisis scenarios
Repricing existing LIBOR positions to SOFR
Designing new products referencing SOFR
• Clients’ needs and SOFR product design
• Pricing of SOFR products
Copyright © Oliver Wyman 28LIBOR AND SOFR PRODUCTS ARE EXPECTED TO PERFORM
DIFFERENTLY THROUGH ECONOMIC CYCLES
Interest rates 1M LIBOR – 1M Compounded SOFR Spreads
January 1, 2019 – April 1, 2020 April 1, 2018 – April 1, 2020
3% 1.00%
0.75%
2%
0.50%
1%
0.25%
0% 0.00%
Jan 2020 Feb 2020 Mar 2020 Apr 2020
Apr-18
Jan-19
Apr-19
Jan-20
Apr-20
Jul-18
Jul-19
Oct-18
Oct-19
1M USD LIBOR 1M comp. SOFR in arrears
-0.25%
SOFR AMERIBOR
Note: 1M compounded SOFR in arrears are filled in using forward rates starting March 1, 2020.
Source: Bloomberg, Inc.
Copyright © Oliver Wyman 29IN A CRISIS SCENARIO (SUCH AS 2020), THE HISTORICAL SPREAD
IS NOT ADEQUATE FOR LOANS TO BE VALUE NEUTRAL
SOFR portfolio likely to yield less revenue in crisis over a year
Margin over LIBOR
Bps 0 50 100 200 500
Additional margin, i.e., spread
adjustment, for SOFR loans
0 -43% -25% -18% -11% -5%
5-yr historical
10 -29% -17% -12% -8% -4% 1M LIBOR to
1M comp.
25 -8% -4% -3% -2% -1% SOFR spread
50 28% 16% 11% 7% 3%
Notes:
Interest revenue percentage differences calculated for a loan portfolio referencing 1M LIBOR and a loan portfolio referencing 1M
compounded SOFR in arrears. Loan resets are equally distributed across business days of a month. Historical rates used up to April 1,
2020, forward rates used thereafter. Data from Bloomberg, Inc.
Copyright © Oliver Wyman 30LENDING WITH SOFR
LIBOR and SOFR in crisis scenarios
Repricing existing LIBOR products to SOFR
Designing new products referencing SOFR
• Clients needs and SOFR product design
• Pricing of SOFR products
Copyright © Oliver Wyman 31REGULATORY CONCERNS FOR TRANSITION FOCUS ON “FAIRNESS”
CREATING A NEED TO ANALYZE IMPACT ON CLIENTS
Regulatory concerns How would you reprice this “reasonably”?
• 3M LIBOR +125 bps loan
– Issued in 2019, matures in June 2022
An overarching concern …
• Different scenarios have different value neutral margins
will be whether firms have
• Adjustment to margin for SOFR as the replacement rate
taken reasonable steps to treat
customers fairly. Market Crisis with Strong recovery
implied rates delayed recovery in 2021
LIBOR discontinuation should
not be used to move customers
with continuing contracts to
replacement rates that are
expected to be higher than +30 bps +45 bps +38 bps
what LIBOR would have been, • ARRC recommended cash product spread will likely
or … introduce inferior terms. differ from value neutral spread (today 25 bps)
FCA, Conduct risk during LIBOR • Clients will compare to what is offered “on the run,”
transition, November 19, 2019 regardless of historically-based adjustments
• Which will you use?
Copyright © Oliver Wyman Calculated using LIBORITHMICS™, Oliver Wyman’s analytics tool, 4/7/2020. 32LENDING WITH SOFR
LIBOR and SOFR in crisis scenarios
Repricing existing LIBOR products
Designing new products referencing SOFR
• Clients’ needs and SOFR product design
• Pricing of SOFR products
Copyright © Oliver Wyman 33DESIGNING NEW SOFR PRODUCTS REQUIRES BALANCING A BANK’S
OBJECTIVES WITH CONSTRAINTS AND CUSTOMER PREFERENCES
Bank objectives Client preferences
• Maintain client trust • Product to work with operational
• Address client needs effectively constraints
• Transparent product features
• Achieve business targets
and behavior
• Manage risks of new products
• Product compatible with hedges
prudently
as needed
• Offer competitive pricing
• Fair and competitive pricing
and services
Copyright © Oliver Wyman 34SOFR POSES NEW CHALLENGES IN HOW IT IS USED AS A REFERENCE
RATE AND HOW SOFR PRODUCTS CAN MEET CLIENT PREFERENCES
Loan pricing features
Example customization to client preferences
Client needs and preferences
Product Fixed Floating
Precise Cash flow
cash flow uncertainty Reference
Select other rates SOFR
certainty acceptable rate
Simple
Complexity Term Comp. in Comp. in
Low Use of rate average in
SOFR advance arrears
complexity acceptable advance
New FTP and In reference
Based on
Spread historical data
bottom-up to existing
calculation LIBOR product
Rate stability Hedge
relevant compatibility
important Option None Floors Caps Other
features
Copyright © Oliver Wyman 35CLIENT ACCEPTANCE COULD BE LOW EVEN FOR SPREADS SIMILAR
TO THOSE IMPLIED BY INDUSTRY CONSULTATIONS
Market implied rates Crisis with delayed recovery Strong recovery in 2021
3% 3% 3%
2% 2% 2%
1% 1% 1%
0% 0% 0%
Oct 2020
Oct 2021
Apr 2020
Jul 2020
Jan 2021
Apr 2021
Jul 2021
Oct 2020
Oct 2021
Oct 2020
Oct 2021
Apr 2020
Jul 2020
Jan 2021
Apr 2021
Jul 2021
Apr 2020
Jul 2020
Jan 2021
Apr 2021
Jul 2021
5-year historical 5-year historical 5-year historical
median spread
27 bps median spread
32 bps median spread
30 bps
Spot spread Spot spread Spot spread
during transition
~19 bps during transition
~13 bps during transition
~35 bps
Client acceptance ? Client acceptance ??? Client acceptance Yes
3M USD LIBOR 3M Comp. SOFR in arrears
Copyright © Oliver Wyman 36BROADENING PRODUCT FEATURES CAN PROVIDE AN EDGE IN
CHALLENGING CLIENT OR COMPETITIVE ENVIRONMENTS
LIBOR Interest rate Cash flow and
transition scenario discounting
capabilities capabilities
analytics
Contract 1 Contract 2 Contract 3 Contract 4
Contract
features Loan $10 MM Loan $10 MM Loan $10 MM Loan $10 MM
Maturity 4/14/25 Maturity 4/14/25 Maturity 4/14/25 Maturity 4/14/25
that are
Base rate 3M LIBOR Base rate 90D SOFR IA Base rate 90D SOFR IA Base rate 90D SOFR IA
value Margin 125 bps Margin 162 bps Margin 153 bps Margin 125 bps
equivalent Floor No floor Floor No floor Floor 2.50 % Floor 2.95 %
Contract example analyzed using LIBORITHMICS™, Oliver Wyman’s LIBOR transition analytics tool,
interest rate simulations in collaboration with ARPM
Copyright © Oliver Wyman 37KEY TAKEAWAYS FOR SOFR PRODUCT DESIGN AND PRICING
1 Banks will develop numerous new products
referencing SOFR and other rates to address
client needs across segments
ARRC recommended spread adjustment may
2 not be perceived acceptable by clients for
cash products
Analytics are needed to study scenarios and
3 get product pricing right
Copyright © Oliver Wyman 38GET READY: THE FED’S MAIN STREET LENDING PROGRAM
MANDATES SOFR (DID YOU EXPECT LIBOR?)
• Overview (as of April 13; program details are not final)
–The Fed is setting up 2 lending facilities for small/mid-size businesses: Expanded Loan
Facility & New Loan Facility
–The loans are carried on bank books
–The Fed’s Special Purpose Vehicle (SPV) will purchase 95% participation when eligible
–The SPV will be operational ASAP and cease by 9/30/2020. Maximum size $600 Billion
• Loan term extract:
–4 year maturity
–Deferred amortization of principal and interest for 1 year
–SOFR + 250-400 bps (“which” SOFR not specified)
Is this good for your balance sheet – or not?
Can you use SOFR in your systems and analytics?
Do you know how to compare this to a similar set of LIBOR loans?
Copyright © Oliver Wyman 394
GETTING ADAM
TO GREEN SCHNEIDER
Partner, LIBOR Co-Lead
THROUGH
Adam.Schneider@oliverwyman.com
THE CRISISTHE ROUTE TO GETTING TO GREEN
LIBOR TRANSITION
The route to green requires a careful coordination of activities across:
• Lines of businesses, corporate functions and geographies, Initiate Models & Risk Management
• Infrastructure and operations, Clients & Contracts Infrastructure & Operations
• Legal, risk and finance, Products Manage Financial Implications
• and importantly: Clients and relationship management Path to Green
Top of house
financial Funding and
assessment hedging strategy Update FTP
Product New Product Selling non-LIBOR Stop selling LIBOR
Inventory Design products products
Selling Executive
Successful
LIBOR empowerment Approaching
Transition
products and budget GREEN
GREEN
Exposure Assessment Revised models
Mobilize Work- Contract Legal Fallback Legal Client Fallback
program planning Inventory Review Readiness Review Communications Processing
Client General Renegotiation Revised Vendor & Internal
Inventory Communications Terms Remediation
Technology Inventory Define Technology Engage Potential Stopgaps
requirements Remediation Plan vendors
Since LIBOR was “everywhere” and usage usually not managed, enormous work is needed to
remove it from the financial system.
Copyright © Oliver Wyman 41WHERE ARE YOU NOW?
What does “green” look like as of April 2020?
1
Exposure assessment complete – scope of LIBOR in the firm is known
Assess exposure
Exposures are produced regularly (quarterly? monthly?)
2
LIBOR Transition Office (LTO) fully organized and resourced
Program and
…Although reasonable if resources are re-deployed for COVID for time being
governance
Business and function workstreams mobilized – who is on point well defined
Fallback inventory well underway or complete
Transitioning
Strategies developed for fallback treatment
3
back book
Plans for communications to clients being developed for 2021 implementation
New exposures use robust fallback language
Developing
LIBOR product issuance has an “end” e.g. we will stop by xx/xx/xx
new products
New ARR products and pricing under development
4
Completed risk assessment and identified impacted models
Risk & models
Redevelopment schedule exists, timeline to complete mid-2021 (CCAR 12/31/20)
5
Comprehensive view of impacted tech & ops and required capabilities
Systems
Complete plan developed; updates underway; begun implementing priority systems
6 Manage financial Scenarios defined, detailed top of house financial assessment underway
implications
Copyright © Oliver Wyman
Evaluating implications on funding, hedging, FTP
42APRIL 2020: RECOMMENDATIONS FOR GETTING TO GREEN
Firms that are behind should be strategic in where and how they focus efforts
• Industry is defining key outcomes across products, with 2020 dates
G2G – 1 unlikely to move
Ensure workplans link to
• LTO must integrate industry deadlines to specifics of firm exposures and
industry timelines
then do business work plans so as to keep progressing
• LIBOR cessation date still in force; underlying submissions very low
G2G – 2
• Shift in focus near-term is reasonable; but do not let the urgent
Maintain focus despite overwhelm the important
real-world urgencies
• Continue engagement with committees/execs
• LTO as the nerve center via “Smart PMO” practices
G2G – 3
• Ensure clear ownership of activities across the firm
LTO continues to orchestrate
• LTO empowered to monitor timelines and “jawbone” progress
G2G – 4 • Maintain progress in areas with long lead-times
Be prepared for a Fall 2020
• Ensure program can “surge”; define areas and resources required
“surge”
Copyright © Oliver Wyman 43G2G 1: ENSURE WORKPLANS LINK TO INDUSTRY TIMELINES
2019 2020 2021
Capability Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
Fannie Mae and Freddie Mac
NY FED publishes ARRC recommended spread SOFR swaptions LIBOR
Key industry assumptions €STR published
SOFR averages for cash products
ceased purchasing long-dated
LIBOR-based ARMs
actively traded discontinued
CCP SOFR discounting
Discontinuation of
Tax, regulatory, and FHLBanks cease to enter long-dated
LIBOR-lending in Pick-up in SOFR FRNs Create a SOFR term reference rate
accounting rule relief LIBOR-based instrument
SONIA averages Sterling markets
ARRC publishes proposal for
Effectiveness of the amendments to the Pick-up in SOFR ARM and
NY State legislation to reduce the
2006 ISDA definitions and protocol bilateral commercial loan origination
legal uncertainty of the transition
Operational Contingency time
1. Assess Exposure Assess LIBOR Exposure readiness, testing and
remediation
2. Mobilize the LTO Mobilize workstream
3a. Identify fallbacks and determine Extract fallbacks Insert new fallback language in LIBOR contracts
transition approach Determine transition approach
3b. Develop new ARR products Design ARR products & pricing Launch ARR products
3c. Manage client communications Define bank-wide comm. strategy Continuous update Fallbacks updated/negotiated/processed
4. Assess risk and update models Update and validate models referencing LIBOR1
Assess risks Create mitigating actions Monitor risk
5. Update systems Prioritize and fund Implement capabilities to process ARR products1
technology and
vendor needs Collect fallback data and build processing capabilities1
6. Manage the financial implications Determine scenarios and top of house financial impact New product pricing and analytics
Develop funding and hedging strategy Update FTP
1. Non-discrete, varies by product/LoB
Today Industry-driven events Potential Industry driven events
External-facing milestones (clients, Internal-facing milestones
Copyright © Oliver Wyman regulators) 44G2G 2: MAINTAIN FOCUS DESPITE REAL-WORLD URGENCIES
Illustrative portfolio composition
• Follow industry deadlines (ex: CCP) with active fallback management
• Maintain focus on systems upgrades Percentage by reference rate
and vendors 100%
• Categorize fallbacks and build out
what you need for transition 80%
• Push on new product development
60%
1 LIBOR: Legacy fallbacks 40%
2 LIBOR: New, robust fallbacks
20%
3 New ARR products
0%
Q1 2020 Q3 2020 Q1 2021 Q3 2021 Q1 2022
Copyright © Oliver Wyman 45G2G 3: LTO CONTINUES TO ORCHESTRATE
Adopt “Smart PMO” practices in the LTO to act as the transition nerve center
Key roles and responsibilities
01 Inject structure and discipline 02 Ensure innovative and
across workstreams best-in-class solutioning
01 02
• Drive program management activities • Challenge workstreams to think
centrally and within workstreams creatively
• Provide tools and set standards • Identify dependencies and ensure
for workstreams cross-functional collaboration
• Manage investment budgets Imperative • Assure adherence to design
and implementation planning of the LTO principles during rollout; review
05 03 design issues
05 Provide content support 03 Accelerate delivery
• Provide advisory support for • Introduce approaches to accelerate
workstream leads 04 workstream completion
• Drive decision-oriented, content- • Build momentum through
driven discussions among quick wins
stakeholders 04 Build out transition advocates
• Establish a strong set of senior change
leaders
• Build a cohort of transition advocates
across the firm
Copyright © Oliver Wyman 46G2G 4: BE PREPARED FOR A FALL 2020 “SURGE”
Build Out Technology Get Fallbacks in Order Keep Communicating
• Understand new • Source and digitize • Communicate to keep
system requirements contracts to identify employees and clients
LIBOR exposure informed about LIBOR
• Collaborate with
developments
internal IT team and • Review contract
engage vendors language and define • Keep communicating to
remediation treatment management about
• Prioritize systems likely
buckets nature of work to
to be impacted first
happen under tight
• Implement improved
timelines
fallback language
Aggressively rework and challenge plans, forward-identify resource needs,
prepare to obtain in-house or external resources, build training.
Copyright © Oliver Wyman 47BUT WAIT – WHAT IF THE DEADLINE REALLY DOES MOVE?
Naturally COVID-19 is impacting many bank programs, including LIBOR. While
authorities continue to press for LIBOR ending after 2021, how should you
respond IF transition is delayed…
Market: Continue Alternative Reference Rate (ARR) market development
Additional ARR liquidity is sorely needed. Focus on issuance of existing products,
continuing current programs (e.g. ending LIBOR mortgages) and CCP discounting.
Progress on new fallbacks
Implement good fallbacks for new issuances and the ISDA protocol for derivatives;
save yourself conversion time later.
Finalize SOFR for lending — or not – “fish or cut bait”
Understand the need for another rate, validate against recent market experience,
finalize thinking.
Use the extension wisely
There are two standout activities: Upgrade systems to support the new rates and
manage LIBOR fallbacks. Continue both.
If the program pauses: Inventory and organize to simplify restarting
Most firms’ LIBOR transition programs already have substantial work underway –
invaluable to have this organized and archived so as to support a quick restart.
Copyright © Oliver Wyman 485
DAN
ROSENBAUM
Partner, Financial Services
CLOSING
Dan.Rosenbaum@oliverwyman.com
REMARKSOW IS DEDICATED TO SUPPORTING OUR CLIENTS THROUGH THE TRANSITION Deep understanding of the issues and solutions • We are helping shape the transition as active members of both the U.S.’s ARRC and the U.K.’s Sterling Working Group • We have published many POVs on how firms can best prepare for the transition Pulse on industry priorities and developments • We are in regular dialogue with over 100 institutions (including banks, asset managers, infrastructure providers, insurers, and corporates) and have direct access to key regulatory authorities Real-world transition expertise • We have a coordinated global team working together seamlessly to support clients • Our LIBOR toolkit allows firms to accelerate mobilization and transition LINK to OW LIBOR Transition HUB: https://www.oliverwyman.com/our-expertise/hubs/libor.html Copyright © Oliver Wyman 50
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